Section – 1 : Stock and Stock Market Basics
1) Owners Equity = Net Assets
2) Net Asset = Total Assets – Total Liabilities
3) Lenders expect Interest + Capital.
4) Share = Partner’s percentage interest in owner’s equity
5) Stock = Fixed percentage of ownership in a company or business.
6) Stock Market = Marketplace for stocks, where willing buyers and sellers of stock come together to trade with each other.
7) Trading can happen on a Stock Exchange or as a private exchange between two people.
8) Stock Market is nothing but a platform for network of computers where buyers and sellers transact in any security.
9) Trading of stock happens in Primary Market or Secondary Market.
10) Primary Market is the market where debt or equity securities can be issued by the businesses. The business is known as the issuer of the security. The issuer receives funds from the investors, which may be individuals or institutions. Since the investor buys security directly from the issuer, this market is called Primary market or new issue market.
11) Going Public means allowing Public to buy securities for the first time, in a business.
13) Primary Market Issues –
> Public Issue : Issued to members of public. May be IPO of FPO ( Follow-on PO)
> Private Placement : Qualified Institutional Placement ( Involves bidding from Qualified investors ), Preferential Issue( To identified investors )
> Rights and Bonus Issue : Securities are issued to existing investors. Rights is when Investors pay for new Securities, bonus is when shares are issued without payment.
12) All the securities issued in the Primary Market get traded in the Secondary Market.
13) A Stock’s price reflects this continuous evaluation by Investors and also their expectation of performance of the business.
14) Stock Market Participants
– Retail Investor ( Individual investor with surplus money. Basic knowledge, and usually acts on his knowledge or financial advisor. Simple Investment strategy. Less Quantum.
— Institutional Investor ( e.g. Banks, Mutual funds, etc). Specialized knowledge and skills in investing. Complex investment strategy, and achieve results using derivatives. Quantum is large, and have fund mangers to manage the corpus.
15) IPO stands for Initial Public Offering. Its first public offer, and Post IPO – Shares become widely available for investment, and new types of investors become shareholders.
16) IPO -> Fresh Issue ( Company issues new shares, Capital goes up, % share goes down), Offer for Sale( No new shares, No Capital impact, Offered % shareholding goes down, not offered shares percentage stays)
17) FPO -> Follow-on Public Offer is made by companies that are already listed on the exchange, when they require additional capital for growth, or restructure capital by retiring debt.
18) Primary market is where securities are issued for the first time. Once that process is complete, these securities become available to be traded on stock exchanges. The universe of securities that you can trade on stock exchanges actually constitute a secondary market.
19) The main functions of a secondary market are liquidity and price discovery. Liquidity means the ability to buy and sell shares, as per the shareholder’s wishes. Price discovery means, the price at which the business can raise more funds, because Secondary market performs constant evaluation of the future progress of the company.
20) Data from Secondary Market is also used to generate benchmark indices. e.g. Sensex and Nifty in India.
21) In Secondary market, the stock prices are the result of continuous buying and selling of various types of participants in the market. This includes retail investors, institutional investors, short term and long term traders and market makers. It is set by the collective wisdom of all the participants.
22) There are two ways in which an IPO may be priced – Fixed Price or Dutch. In fixed price issue, company decides the price, in consultation with Lead Manager. The price is decided based on the expected performance and price of shares of comparable companies. In Dutch or Book Built Issue, price is decided by Auction. The company and the lead managers set a floor price or a price band, and finally decide on a cut-off price.
Section – 2 : Stock Exchanges, Financial Intermediaries and Stock Index
- Trading in secondary markets happens on stock exchanges. Its a platform where willing buyers and sellers transact on various financial securities,one of them being stocks.
- Any person who wants to buy or sell stock can do only via Stock brokers or Trading members. Members of exchange can be trading, clearing or both.
- There are three phases in a secondary market transaction –
- Trading is where actual buying and selling of securities happens. All Investors route their orders to brokerages. They collect orders from various investors and route it to exchanges. Clearing process is a process of identifying which securities and in what quantities is owed to which buyer, the clearing process also identifies what amount of payment is owed to the seller for this transaction. Clearing process is owned by Clearing house. Settlement process is process where securities and payments are made to respective investors.
- Various Intermediaries
- Trading Members – Stock brokers and affiliates( sub brokers)
- Clearing House – Independent party that conducts the clearing process
- Depository & Depository Participant – Depository maintains a list of all the securities you own, and facilitate the exchange of securities. Only electronic or dematerialized securities can be traded. Depositories appoint depository participants who act as intermediary between the depository and the investors . so, every investor is required to hold a DEMAT account with the depository participant. The settlement of securities is done in this DEMAT account.
- Securities : Securities represent terms of exchange between two parties. Issued by many organizations such as Corporate, Government, Banks and Financial Institutions. Used to convert Savings to Financial Assets.
- Stock Index : Number representing a section of the stock market. Usually one stock exchange representing an exchange is popular.
- Two primary ways of calculating index – Price weighted and Market Weighted Index. Price Weighted = Sum total of stock prices divided by number of stocks.
Market Weighted Index is Weight determined by market capitalization.
Section – 3 : Queries on Stock Market Trading
- In order to start trading, Set up a trading account with stock broker and transfer funds.
- Basic flow while trading stocks – Trade/ Order Initiation, Risk Management/ Order routing, order matching and trade execution, Clearing and Settlement.
- Bid Price – Price a buyer is willing to buy for security.
- Offer Price – Price a seller is willing to accept, in order to part away with security.
- Order Types – Market, Limit, Stop Loss and Combinations.
- Market Order – Instructs the broker to buy/sell security at the best price available in the market. Market Sell – Filled at highest available bid price. Market Buy – filled at lowest available offer price. Advantage is that your entire order will be definitely executed. Dis advantage – cannot be sure at what price orders will be filled.
- Limit Order – Specify a limit price and a quantity. Limit buy order – Filled at or below the limit price. Limit Sell Order – Filled at or above the limit price.
- Stop Loss Order – Limit the losses on your trade. Instructs the broker to get you out of trade if prices hit stop loss price. Two types- Stop Loss Market Order / Stop Loss Limit Order. Stop Loss Market Order exits at best available market price. Stop Loss Limit Order exits at best available market price, subject to getting a fill at the limit price.
- Types of brokers – Full Service Brokers and Discount Brokers. Discount Brokers deal only with securities trading, and Full Service Brokers will provide lot more services for a nominal price.
- Website Availability, Minimum Deposit amount, Product you’d like to trade and Interest offered by them for your deposit are the key factors that should be considered before choosing a stock broker.
- Algorithmic Trading uses Mathematics and Computer Programming to reduce the effect of emotions and biases.Mainly used for two key purposes – To automate execution for efficiently execute large orders ( Algorithmic Trading) or To place automated trades in order to profit from them.
- In order to try using Automated Trading, knowledge on computer programming and Statistics is a must. It is not recommended for beginners.
- Quick stat on how much to invest in Stocks –
- Accumulated Savings – Savings in your lifetime
- Emergency Fund = 6 months of your monthly essential investments
- If Accumulated Savings > Emergency Fund, Investment Portfolio = Accumulated Savings – Emergency Fund – Liquidity Requirements over next 1-3 years.
- If Investment Portfolio is 20-30% of savings: 100% Equity
- If Investment Portfolio is 60% of savings : Allocate most of the capital in fixed.
- Diversify Equity Allocation – Stocks ,Mutual Funds
- Beginner Investor –
- Invest most of the money in Mutual Funds, Substantial but smaller portion in Individual Stocks.
- Learn Investing skills and Invest based on your own analysis.
- Passively invest if you do not have time.
- Ideally no more than 10% of Investment in one security
- Futures & Options :
- Hedging ( To offset losses of other investments) is the primary purpose of Futures& Options.
- Futures Contract is a derivative Instrument – Financial Contract between two parties.
- Future Contracts on Stock – An agreement to deliver a stock at a certain price
- The difference in agreed contract price & prevailing stock trading price is paid by the seller to the buyer, and is called Cash Settlement in Futures Contract.
- Options give buyer the right but not obligation to buy/sell underlying. It can be stock, stock index, commodity or currency. Option sellers is always obligated to buy or sell a security, depending on the type of option.
- Call Option gives the buyer the right but not obligation to buy an asset within a certain period at a certain price.
- Put option gives the buyer the right but not obligation to sell an asset within a certain period at a certain price. Options premium is the profit for seller.
- Only once you are profitable in Cash market, venture into Futures & Options
- Mutual Funds – Investment Corpus is created from the investment of many individual investors, and then collectively managed by fund manager for investment into asset classes as per the fund nature. It can be equity, debt, gold or real estate.
- Corporate actions are actions on share capital that directly affect shareholders.
- Dividends – Share of profits received by Shareholders
- Share Repurchase – Company buys back some of its shares from the market
- Bonus issue – Bonus made to existing shareholders. They receive shares for no extra cost.
- Rights Issue – Giving existing shareholders first rights to buy new shares of the company. Investors have the option to share their rights entitlement.
- Mergers & Acquisitions – Deal with buying, selling, diving and combining similar entities and companies. Merger is consolidating two companies. Acquisition is when one company acquires another.
- Two important dates : Ex-date and Record date.
- Ex-Dividend and Ex-bonus : Dates to purchase security to be eligible for Dividend and Bonus.
- Record Date : Date on which company records are checked to determine eligibility.
- Date of Payment : Date on which company will pay dividend or bonus according to the records on record date.
Section – 4 : Understanding Financial Statements
- Financial analysis of a company is critical before investing into it.
- Two main categories -> Debit, Equity
- Debt is where Investor is concerned about Principal & Interest rate.
- Equity is where Investor is concerned about Dividends and Gains from Growth.
- Components of Financial Statement –
- Balance Sheet : Statement of Financial Position
- Profit & Loss : Statement of Income
- Statement of Changes in Equity
- Statement of Cash Flows
- Notes to Account
- Management Discussion & Analysis
Section – 5 : Common Size Analysis of Financial Statements
- Liquidity – Ability to meet short term obligations ( Able to convert trade receivables to cash)
- Solvency – Able to meet long term obligations (ability to manage assets and liabilities)
- Here are the steps for common size analysis ofExpress each line item as percentage of total assets
- Track changes in Balance sheet over period
- Compare balance sheet of different companies over time
- Here are the steps for common size analysis of Income Statement
- Divide each line item with revenue or total assets
- Multiple revenue sources can be decomposed
- Common Size Analysis of Cash Flow Statement
- Divide each line item with revenue or total assets
- Approach 1 : Cash inflow and outflow
- Approach 2 : Net Revenue
Section – 6 : Financial Ratio Analysis of Financial Statements
- Calculated using items from balance sheet/ income statement
- Used to evaluate performance /compare valuations.
- Various Financial Ratios –
- Activity Ratios
- Liquidity Ratios
- Solvency Ratios
- Profitability Ratios
- Valuation Ratios
- Activity Ratios measure how the company performs day to day tasks.
- Liquidity Ratios measure how the company meets short term obligations
- Profitability Ratios measures a company’s ability to generate profits
- Valuation Ratios measure the quantity of asset associated with company’s share
Section 7 : Benjamin Graham’s Value Investing Strategy
Benjamin Graham, widely regarded as the Father of Value Investing lays down these ground rules for Investing –
- Sale of atleast $100 million
- Current Ratio > 2
- Some Profit every year for last 10 years
- Earning growth of 33% over the last 10 years
- Price to Earnings < 15
- Price to Book Value < 1.5
- Regular and Consistent Dividends
Graham’s number = 22.5 X Earnings per share X Book Value per share
Section 8 : Technical Analysis
- Price and Volume based analysis to predict future stock movement
- Often displayed graphically for ease of use and decision making
- Application not limited to any asset class
- Logic of Technical Analysis –
- Supply + Demand = Prices
- Change in Supply AND/OR Change in Demand = Change in Price
- Doesn’t need Investor to know in detail about the investment, and has no time frame
- Investors with shorter time frame often prefer TA ( Technical Analysis)
- Principles & Assumptions behind Technical Analysis –
- Study of Collective Investment Psychology or Sentiment
- Doesn’t believe in rational human behavior
- Market Trends & Patterns repeat themselves
- Market reflects collective knowledge and sentiment
- Technical Analysis vs Fundamental Analysis
- TA – Focus on Price & Volume Data. Objective.
- FA – Focus on Financial and Economic Analysis. Societal and Political Trends.
Section 9 – Introduction to Charts
- Charts are a graphical display of price and volume
- Three kinds of charts – Line charts, Bar Charts and Candle Stick charts
- Charting Considerations
- Y-axis log scale or arithmetic scale
- Volume of security traded along with price movement
- Time Interval – Short term( within a day) or long term( by time periods)
Section 10 – Candlestick Patterns
- Candlestick data points –
- Opening Price, Closing Price, High of the day, Low of the day
- Spinning Top – Indecision, trading across wide range of prices
- Doji – Open and Close price same, so candlestick becomes a cross
- Types of Doji
- Long Legged – Indecision, typical cross
- Gravestone Doji – Open Price = Close Price = Low Price
- Dragonfly Doji – Open Price = Close Price = High Price
- Reversal Candlesticks pattern –
- Combination of Candlesticks that indicates a reversal in trend
- Pay attention to trends before the occurence of pattern
- Bullish pattern is valid after a downward trend
- Bearish pattern is valid after an upward trend
- Reversal Patterns –
- Engulfing Pattern – Can be bullish or bearish. Black candlestick engulfed by larger white candlestick – Bullish. The opposite is bearish.
- Dark Cloud Cover – Start bullish, the next day opens higher than previous day but keeps falling continuously. And day turns bearish.
- Piercing Line Pattern – Start bearish, the day opens lower than previous day but keep increasing continuously. And day turns bullish.
- Evening Star – Three day pattern. Bullish, trading above the high – but close lower than open ( bearish) and then downward bearish.
- Morning Star – Three day pattern. Bearish, trading above low – but close higher than low( bullish) and then upward bullish.
- Candlestick Continuation Patterns –
- Rising Three Patterns – First day – bullish, second, third and fourth day – two black and one white candlesticks all within the first white candlestick and then the fifth day candle stick is bullish and bigger white box.
- Falling Three Patterns – First day – bearish, second, third and fourth day – two white and one black candlesticks all within the first black candlestick and then the fifth day bigger black candle stick with a new low.
- Three white soldiers – Three upward white candlesticks, after a consistent rest phase, indicating an upward trend. Wicks are smaller, and there is alternate pattern between closing at high and low
- Advancing Block Pattern – Second and Third candlestick shows upward tick. Indicates caution for investors.
- Stalled Pattern – Two white long candlesticks, followed by a short candlestick.
Section 11 – Gaps
- Myth – A Gap created once must be closed.
- Reality – Not all gaps will be closed.
- Gaps that dont matter
- Gaps in Thinly traded stocks
- Gaps in Ex-dividend ( after dividend)
- Gaps that dont matter
- Common or Area Gaps
- Breakout or Breakaway Gaps
- Continuation or Runaway Gaps
- Exhaustion Gaps
- Area Gap – Occurs in Price congestion formation. Heavily traded stock, gaps close in a matter of few days or weeks. Ends before formation ends.
- Breakaway Gap – Appears in connection with price congestion, Appears at the end of the formations. Alerts the investor that breakout in the prices has happened, Prices expected to move farther or faster or farther & faster. but, this gap doesn’t tell how far the move may extend.
- Runaway Gap – Appears unrelated to congestion. Appears in random bursts. Also called measuring or continuation gap. The no. of points of difference between gap is the same no. of points of difference after the gap.
- Exhaustion Gap – Comes at the end of the move. Indicates sharp fall, after excessive demand for not equal supply. will cover in 2 to 5 days.
Section 12 – Support and Resistance
- Support is an area of buying powerful enough to halt a downtrend.
- Resistance is the price level or price range where up trends pause.
- Support level has concentration of demand
- Resistance level has concentration of supply
- Price levels keep changing their roles as support or resistance level
- Support becomes Resistance if prices trade below it
- Resistance becomes Support if prices trade above it
- Criteria to determine the relative strength of support or resistance – Volume, Distance traveled and Time elapsed.
- Volume – The higher the volume, the greater support or resistance
- Distance Travelled – Greater distance, higher resistance levels.
- Length of time – Amount of time spent
Section 13 – Technical Indicators
- Measure based on price, market, sentiment or fund flows that can be used to predict changes in place
- Price based indicators use current and past history of market prices
- Moving Averages –
- Simple, Weighted or Exponential
- Simple Moving Average = Average of Prices over 5 days( for 5 day average)
- Weighted Moving Average = More weight to recent price, and progressively less price to older prices.
- Exponential Moving Average = Fastest to respond to moving prices
- Security in downward trend will trade below its moving average
- Security in upward trend will trade above its moving average
- Penetration of moving average may signal change of trend
- Longer time frame = Significance of Cross over
- Act as important Support or Resistance Zone
- Bollinger Bands –
- Three lines – Moving Averages, Lower and Upper bands( using standard deviation)
- Standard Deviation is a measure of volatility
- Create Computerized Trading Strategy
- Will work when prices are less volatile
- Used to discern extreme changes in sentiment
- Oscillate between high and low or a high and low number
- Used to spot convergence or divergence between indicator and prices
- Momentum Oscillators
- Also called rate of change( ROC) oscillator
- Oscillates around zero
- ROC Oscillator crosses from below zero to above zero- buy for uptrend
- ROC Oscillator cross from above zero to below zero – sell for downtrend
- Divergence is not an actionable indicator
- Relative Strength Indicator( RSI )
- Compare Security’s Gains over losses over a period of time
- Momentum Oscillator, tells whether an asset is overbought or not.
- Oscillates between 0 and 100
- Values above 70 = Overbought Situation
- Values less than 30 = Oversold situation
- Less Volatile Stocks = Lower RSI number
- High Volatile Stocks = Higher RSI number
- 14 day time period used to calculate RSI
- Stochastic Oscillators
- Based on observation that, prices close near their highs in uptrend
- Based on observation that, prices close near their lows in downtrend
- Oscillates between 0 and 100
- Oscillators consists of %K line and %D line
- 14 day time period used to calculate RSI
- default oversold / overbought range = 20/80
- %K line crosses %D from below = Bullish
- %K line crosses %D from above = Bearish
- Should be used along with trend lines
- MACD : Moving Average Convergence Divergence
- Difference between short term and long term moving average of security price
- MACD Line – Difference between Day 12 and Day 26 exponential moving average
- Signal Line – 9 day average of MACD line
- Oscillates around 0, has no lower or upper limit
- MACD Line crossing Signal line from below, Bullish
- MACD Line crossing Signal line from above, Bearish
- Look for MACD Extremes ( Outside normal range)
- Use trend lines to detect divergence
Section 14 – A Trading Pattern for all time frames and asset classes
- What makes a great trading pattern?
- Detailed Trading Pattern DNA
- Clear Confirmation Signals
- Complete Trading Strategy
- Trade Setup
- Ending Diagonal Triangle or Wedge
- Rising Pattern or Falling Pattern
- Rise / Fall – Refer to overall price movement
- Rising Pattern : Up and on completion, Goes Down.
- Falling Pattern : Down and on completion, Goes Up.
- Three things to consider – Trigger price, Stop loss price and Profit booking price
Section 15 – Introduction to Options
- Option is a contract that gives the buyer of the contract the right but not the obligation to buy or sell the underlying at a specific price within a specific price period.
- In Financial markets, underlying is Stock, Commodity, Currency, etc.
- Key terms –
- Call Option : Gives holder right to buy, seller obligated to sell
- Options Premium : Money paid to reserve the underlying
- Strike Price : Price to be totally paid while taking over the underlying
- Time to Expiry : Duration seller will hold their underlying
- Put Option : Gives holder right to sell,seller obligated to buy
- Strike Price related to Stock Price :
- Current stock price > Strike Price : In the Money ( ITM)
- Current stock price = Strike Price : At the Money( ATM)
- Current Stock Price < Strike Price : Out of the Money(OTM)
- Options with Only intrinsic value are trading at Parity
- Options with time value are trading at Premium over parity
- Two styles of exercising styles –
- American Style : Can be exercised anytime from the time buyer enters contract until it expires
- Eurpoean Style : Exercised only at expiration
- Eg. BUY 1 AAPL 100 Dec Call 170 at $3
- BUY – Buying a call option
- 1 – Size of the contract
- AAPL – Apple share
- 100 – Quantity of shares in the option contract
- Dec – last date by which the shares must be bought at this price
- call – Type of contract
- 170 – Strike Price ( price at which call owner will have the option to buy the security before expiry)
- $3 – Price of the premium / Option. Mentioned per share( $300 to pay, here)
- if AAPL is trading at $71,Premium $3 – Intrinsic value of $1 and Time value of $2
- Time Value = Total Options Premium – Intrinsic Value
Section – 16 : Basic Option Strategies
- Buying CALL Option : Benefits from the rise in price of underlying
- Profitable if stock price > stock price after expiry
- Not profitable if stock price < stock price after expiry
- Buying a PUT Option : Benefits from the fall in the price of underlying
- Profitable if stock price < stock price after expiry
- Not profitable if stock price > stock price after expiry
- Long Stock + Long Put (same stock) = Protective Put
- Selling CALL Option : Keep the premium if the stock price goes below the stock price at expiry. The seller wont sell, and will get a profit. Will go to loss as the stock price keeps going up.
- Covered Call Spread : Stock and selling CALL option on the same stock.
- Selling PUT Option : Beneficial if price of stock remains above the strike price of the option. In this case, the seller keeps the entire premium, which is the profit.
Section – 16 : Option Greeks
- What drives options prices?
- Price of the underlying
- Expiry Date
- Volatility in the price of underlying
- Black Scholes Option Pricing Model
- Inputs are Stock Price, Strike Price, time to expiry, Interest rate, dividend and volatility. All other parameters except Strike price is volatile.
- Output is the Theoretical value of Stock
- Output is determined first, and input values are adjusted accordingly
- Option Greeks represents the sensitivity of price of option to change in variables
- Rate of change of Option’s price relative to the price of security
- Delta of CALL remains between 0 and 1
- Delta of PUT remains between -1 and 0
- Absolute value between 0 and 1.
- Delta for IN THE MONEY > 0.5
- Delta for OUT OF THE MONEY < 0.5
- Delta for AT THE MONEY = 0.5
- More towards ITM = delta approaches 1
- More towards OTM = delta approaches 0
- Call Option : Delta approaches 1 as prices rise, 0 as prices fall
- Put Option : Delta approaches -1 as prices fall, 0 as prices rise
- Tracks dynamic nature of Delta
- Rate of change of an options delta for change in price
- second derivative of price of option with respect to stock
- Factors affecting Gamma
- ITM & OTM – Delta changes not much, ATM lot of changes
- So, ITM/ OTM have low gamma, ATM has high gamma value
- Theta measures the time decay, not a constant
- Measures rate of change of option’s price for unit change in time
- Variables influencing Theta
- Moneyness of the value ( ITM/ OTM / ATM)
- Volatility( Directly proportional )
- Days to expiration
- Relationship between price of Option and Volatility
- Change in Option price for 1 unit change in implied volatility
- Variables influencing Vega
- Moneyness of the value ( ITM / OTM / ATM)
- Implied volatility
- Days to expiration
- Measures the change in options value relative to Interest rates
- Higher time to expiration has higher impact
- Rho is Negligible for Short term options
- Put Call Parity
- Stock = Call + Strike – Interest – Put + Dividend
- Call = Stock + Put – Strike + Interest – Dividend
- Put = Call – Stock + Strike – Interest + Dividend